The rupee hit a record low today, something market players had foreseen. The currency slumped to 76.92 to a dollar, coming within a hair’s breadth of the psychological mark of 77 per dollar.
Indeed, with Brent crude oil’s continued surge to the current $130 per barrel, the impact on India’s balance of payments and inflation could turn ugly. There is also the prospect of continued dollar outflows as the US Federal Reserve begins to tighten its policy through rate hikes.
A wider current account deficit (CAD) would mean India has to find a bigger stash of dollars to finance it. In essence, foreign investors need to bring in dollars, either to set up long-term assets, such as factories, through direct investment or invest in Indian equities and bonds. Further, India’s services exports need to increase to make up for the wide trade gap. All these are unlikely to happen, economists at Barclays wrote in a March 3 note.
Also read: Brent tests $139 on fears of ban on Russian oil
Trade me red
The trade gap is the difference between imports and exports of goods and services. India has, historically, run a trade deficit, given its heavy oil import bill.
In FY21, the trade gap was nearly 60 percent lower, at $101 billion, compared with the previous year because the demand for oil reduced in the wake of the pandemic. Also, crude oil prices were soft, which made the import bill manageable. Exports of services held up, narrowing the trade gap.
The trade gap is expected to widen this year simply because the growth in services exports may not be at the same pace as the surge in the oil import bill.
The trade deficit had already widened to $21 billion in February 2022, compared with $13 billion a year ago, data showed. Analysts have begun to warn of the widening of the CAD this year and the next. A $10 per barrel increase in crude oil could drive up CAD by $10-15 billion, according to estimates by economists at Barclays.
In FY21, India’s current account was at a surplus of $34 billion, as imports fell sharply, thanks to low demand and softer oil prices. The Barclays economists expect the current account to swing to a deficit of $86 billion in FY22, owing to the rise in oil prices.
“The recent increase in crude oil prices beyond $110/bbl and simultaneous revival of domestic demand pose headwinds to India’s current account balance as the import bill will likely remain elevated,” the Barclays note said.
No love for India
With the CAD widening, India needs dollars to finance it. This is where it gets worse for the rupee. Foreign portfolio flows are a key source of dollars. Foreign Direct Investment (FDI) has remained resilient. Net FDI flows in the first nine months of FY22 were $26.7 billion. Portfolio flows totalled a negative $1.86 billion up to December. Since January, foreign investors have pulled out $11 billion from domestic equity and bond markets.
The upshot is that dollars will flow out of India this year, thereby making it a challenge to finance the CAD. This will reflect in the forex reserves which may fall, the note said.
Foreign investors have turned against emerging market economies in the wake of the Russia-Ukraine war, and India too belongs to the risky camp of emerging markets. With the Reserve Bank of India (RBI) reluctant to tighten policy despite an increase in inflation, foreign investors see little reason to buy Indian bonds too, it said.
Ergo, dollar inflows into the bond market, too, is likely to be muted.
Sentinel at the gate
Forex market participants are putting their faith in the Reserve Bank of India (RBI) to keep the rupee from falling to an uncomfortable level. Economists believe that the central bank would increase its interventions in the market, emboldened by a record stockpile of forex reserves.
The RBI has turned net seller of dollars since November last year in the market. The more than $1 billion fall in forex assets last week points to the central bank’s likely intervention. Even so, historically the RBI has been careful in its forex market operations. That is because the central bank couldn’t support the rupee in 2013 when the currency fell a whopping 6 percent in a single month after the US Federal Reserve announced its tapering.
An encore of the same is unlikely now but it would be foolhardy to expect the RBI to defend a particular level of the rupee steadfastly.
The rupee has everything going wrong for it this year. Its depreciation is a given, although the extent of the rupee’s pain would depend on the RBI’s approach to the market in the coming months.
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